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Sour Grapes: Case Puts ACA at Risk

The bankruptcy of a Napa, Calif.-based nonprofit could deal a significant blow to the remaining statutory capital of bond insurer ACA Financial Guaranty Inc., a recent financial statement filed by the firm shows.

In its annual report to the Maryland Insurance Administration, ACA said it could lose between $40 million to $50 million on a present-value basis due to interest and principal payments it will have to make on $77 million of bonds outstanding from the now-bankrupt Copia: The American Center for Wine, Food and the Arts.

The insurer has just $101 million in policyholders' surplus and $74 million in contingent capital remaining, as of Dec. 31, its annual statement says. Accounting rules prevent the company from reporting a loss reserve until an actual default occurs. ACA expects it will begin making payments on the Copia bonds in 2011 or 2012, when the $7 million debt service reserve fund runs out.

"The magnitude of the loss given policyholders' surplus and remaining contingency reserve is staggering," said former ACA chief financial officer Thomas Hoens, who has been critical of the restructuring.

It's unclear how this bankruptcy factors into the run-off model and financial projections ACA used as part of its restructuring plans. Financial conditions have deteriorated significantly since Maryland insurance regulators approved the restructuring last year.

Under the restructuring, the administration allowed an undisclosed amount of cash to go to ACA's structured finance counterparties and more than $47 million go to parent ACA Capital Holdings Ltd., which held medium-term notes. ACA has primary-market insurance policies on $5.9 billion par outstanding and secondary-market insurance on $739.9 million par outstanding, according to a Bond Buyer analysis of data on ACA's Web site.

A spokeswoman for ACA declined to comment, citing the ongoing legal issues. Representatives from the Maryland Insurance Administration did not return calls or e-mails requesting comment.

When ACA commented on the bankruptcy in a statement in December, chief executive officer Raymond Brook said, "Regardless of the outcome at Copia, ACA's financial guaranty insurance policy is an unconditional and irrevocable guarantee of the timely payment of principle of and interest on each claim when due."

Copia, founded by the late Robert Mondavi and other vinters, sold $70 million of bonds in 1999 to finance the construction of the so-called Wine Shrine. But actual attendance at the museum fell well short of expectations and the nonprofit lost at least $5 million every year since opening in 2001 - including a $12.7 million loss in 2006.

Despite the losses - and a boldface warning on its official statement about "substantial doubt regarding Copia's ability to continue as a going concern" - the nonprofit in 2007 managed to refinance its debt in a $77 million deal sold via the California Infrastructure and Economic Development Bank thanks to a guarantee from ACA. JPMorgan served as the senior manager, with Orrick, Herrington & Sutcliffe LLP as bond counsel.

In addition to the financial troubles, the bonds could now cause legal headaches, too. A creditor has submitted a plan in which it would attempt to get back for the entire Copia bankruptcy estate money held in escrow for the 1999 bondholders as part of the refunding because of a botched defeasance.

MacConaghy & Barnier PLC is representing Copia. Nixon Peabody LLP is representing ACA. McGrane Greenfield LLP and Venable LLP are representing Copia Claims LLC, a claims trader that purchased a $12,000 unsecured claim for $4,000 after the bankruptcy and then filed motions trying to stop an agreement between Copia and ACA. It wants to sue the indenture trustee to reclaim the escrow money for the estate.

THE BANKRUPTCY DISPUTE

After declaring bankruptcy, Copia had planned to use its museum - which it spent $55 million to build in 1999 - to secure a $2 million line of credit to reorganize, but ACA sought to foreclose on the property and block the move. The court denied Copia's motion, leaving liquidation as the only option.

Eventually, the two sides reached an agreement in which ACA and trustee Bank of New York Mellon - acting for the 2007 bondholders - would essentially have gotten the building in return for waiving any deficiency claims the 2007 bondholders would have against Copia.

They would have also waived their secured collateral rights to paintings worth about $138,000 and paid an additional $327,449 "carve-out" as a concession to local employees of the facility, for wage and benefit payments, and consumer deposits. They estimated remaining unsecured creditors would have been left payoffs of about 5% on their claims, court documents say.

But a third party stepped in to question the agreement. Copia Claims LLC argued that its filings showed that Copia's attempt "to railroad a collusive settlement with ACA in which the assets of the 2007 bondholders are used to buy peace for the 1999 bondholders stands exposed for what it is: the product of a blatant conflict of interest on the part of ACA."

McGrane Greenfield, which represents the bankruptcy claims trader, tried to pursuade Copia's lawyers to pursue a fraudulent transfer claim even before Copia Claims bought a claim, e-mails filed in court by McGrane show. Part of Copia Claims' argument hinges on what it believes to be a botched defeasance of the 1999 bonds.

Orrick, Herrington & Sutcliffe LLP sent an opinion in May 2007 that said defeasance could not yet occur because the trustee, Bank of New York Mellon, had not received an opinion letter on certain topics required by the 1999 indenture, Copia Claims said in court documents.

In August, Orrick did send BoNYM a defeasance opinion. It did not, however, send the trustee the necessary bankruptcy opinion, which was sent to ACA instead and was stated to be only for its use, according to Copia Claims.

But Copia Claims asserts that even if Orrick had sent the bankruptcy opinion to BoNYM the opinion would not have been sufficient because it did not include an adequate discussion of the impact of fraudulent transfers under either federal or state laws.

"Orrick, as the leading public law firm in the United States, was no stranger to transactions such as this one, and was therefore necessarily concerned by the very unusual fact that the Debtor was already insolvent by 2007, despite its part in raising such a large sum of money as $77 million in the public securities market," Copia Claims wrote.

Representatives for the trustee, ACA, and the CIEDB all filed documents in bankruptcy court saying they believed all the conditions necessary for defeasance were met.

If the defeasance never legally occurred, then Copia's liability to the 1999 bondholders remained, which means Copia didn't receive something of fair value in return for putting the refunding bond proceeds into escrow, Copia Claims argues.

The trustee received $71.17 million "at a time that the debtor was insolvent and for no other consideration to the debtor other than the 1999 indenture trustee's later reconveyance of a deed of trust on certain real property owned by the debtor, which real property then had a value as security of no more than" $37.2 million, according to a proposed lawsuit that would be filed if creditors and the court approve the plan.

Copia Claims believes the bankruptcy estate would have a "slam-dunk" fraudulent transfer case against Bank of New York Mellon, as the indenture trustee that would enable it to reclaim for all creditors the remaining $65 million in escrow for the refunding, according to bankruptcy court documents.

Under the plan proposed by ACA and Copia, BoNYM and ACA - acting for the 2007 bondholders - would have waived their right to file an unsecured deficiency claim against Copia. Such a waiver would have left them with just the real estate collateral and a guarantee from ACA that it would pay all remaining interest and principal on the bonds, which is of uncertain value given the financial stress on the insurer, Copia Claims argues.

Standard & Poor's in December estimated ACA had a margin of safety of just 0.5 to 0.7 times its severe stress-case losses when it upgraded the company to B from CCC and withdrew its rating.

Copia Claims asserts that 2007 bondholders would likely prefer to see a fraudulent transfer lawsuit pursued, which would give them a chance to share in the $65 million held in escrow. It also accused ACA and Copia of failing to make adequate disclosures of the plans to the 2007 bondholders, who also would have unfairly been prevented from taking any legal action against the insurer, Copia Claims said.

"As a result of the multiple errors surrounding the botched 2007 'defeasance,' [ACA is] desperately trying to paper over the cracks, pushing through a secretive settlement with the connivance of the debtor-in-possession," Copia Claims wrote in one document filed in bankruptcy court. "So far, the 2007 bondholders themselves have not been consulted; but when they find out what is going on, [Copia Claims] predicts they will revolt."

An ACA spokeswoman declined to comment, citing the ongoing legal issues.

Copia initially resisted the creditors and continued to work with ACA on an agreement. In the proposed disclosure statement on their plan, lawyers for Copia said they didn't believe a fraudulent transfer claim existed, thought that the estate could be sued for trying to pursue one, and that the bond documents gave ACA the power to vote for 2007 bondholders in any reorganization plan anyway, according to court documents.

A NEW PLAN

More recently, Copia relented and worked out an agreement with Copia Claims that it believes "is likely to provide a superior financial return to all parties in interest in the Copia Bankruptcy Case," Copia's lawyers wrote in a motion for authority to incur non-recourse secured debt last Tuesday. It will withdraw its existing motions and agreement with ACA.

As part of the new agreement the judge must approve, Copia Claims will provide $1.35 million of debtor-in-possession financing to the bankruptcy estate. Copia will receive the first $350,000 up front and another $1 million if its amended plan is confirmed by creditors.

The new plan includes Copia Claims pursuing the fraudulent transfer claim at its "sole expense." If the litigation is successful, Copia Claims will get back its $1.35 million, its attorney fees and costs, and 20% of any remaining recovery, with the remainder of the money going to the estate.

Copia's lawyers wrote in the motion that this is preferable because along with the artwork, the first $350,000 will give it the cash to pay off all administrative and priority claims, while the second $1 million will give it the resources to pay a 2% dividend on general unsecured claims. Copia does not turn over any rights to Copia Claims unless the plan is confirmed by creditors, so it essentially gets $350,000 for letting Copia Claims submit a plan to other creditors.

Copia's lawyer concluded that Copia "or any likely trustee lacked the resources and expertise to successfully prosecute the claim, and that it was inappropriate for the estate to bar the risks of an adverse result." Unsecured creditors have the potential to recover at higher rates than under the old plan if the litigation succeeds, Copia's lawyers wrote.

Also, Copia concluded it would been inappropriate to proceed with its previously planned motion without notifying the individual 2007 bondholders, Copia's lawyer wrote.

Although the 2007 indenture says ACA has the right to vote on behalf of the bondholders on a reorganization plan, Copia "has serious concerns with the enforceability of this assignment." A bankruptcy court has ruled at least once that "voting rights cannot be contractually alienated" and BoNYM and ACA have a conflict of interest where they might "sacrifice the property interests" of the 2007 bondholders to prevent litigation against the 1999 bondholders.

Not surprisingly, ACA's financial position is also an issue.

"A serious question has been raised in this case as to the sufficiency of ACA's financial reserves to meet its obligations to the '07 bondholders for sums due on account of their anticipated unsecured deficiency claim," Copia's lawyer wrote. "While the debtor has no independent knowledge of that issue, the debtor considers it another reason for the individual '07 bondholders to be offered the right to vote with full disclosure of their financial options and risks."

ACA still has insurance policies on both sets of bonds, and any potential litigation could further decrease its claims-paying abilities. With the proposed 20% Copia Claims would take beyond any legal expenses for any victory in the proposed litigation, even less will be left in escrow.

Under the motion submitted to the court, the 1999 bondholders would not be allowed vote for or against the plan.

A judge will hold a hearing April 10 on whether to approve a motion that would allow Copia Claims to submit its plan.

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